Down the Warped Path of Regular Deficits

A weaker dollar can’t come fast enough for infrastructure companies. Yesterday’s victim was UGL. The company’s share price fell 17% when it cut its 2013 net profit forecast by 40%. CEO Richard Leupen told the Australian Financial Review that, ‘We’ve seen locomotive sales fall, we’ve seen some of the contracts we’re pursuing in iron ore deferred as projects are delayed, and we’ve seen the same thing happening in coal.

That is not the news resource bulls were looking for. Iron ore prices are down 11.6% since the start of the year.  As Greg keeps saying, it’s a trap.

Incidentally, yesterday’s federal budget estimates that iron ore will hover around US$110 per tonne for the next year. By mid-2015, it reckons the ore price will stabilise at US$100 a tonne. The current price is $128 per tonne. And keep in mind that iron ore is up about 400% in price over the last decade.

All this matters because iron ore and coal generate big revenues for the government. If the forecasts are wrong — and when has that ever happened — then the government will be looking at lower revenues and bigger deficits. And there’s our gratuitous prediction for the day: Australia’s governments deficits will be bigger and last longer than yesterday’s budget suggests.

Once you go down the path of regular deficits, your thinking starts to warp. Consider the glee with which the US deficit data was greeted yesterday. The Congressional Budget Office (CBO) in the US revised down its projected US budget deficit to $642 billion. In February, the CBO thought it would be more like $845 billion. That means the projected deficit shrunk by about 24% thanks to higher tax receipts and lower growth rates in spending.

But it’s still a $642 billion deficit!

In what world is a $642 billion deficit a sign of progress? Granted, the US ran $1 trillion deficits for four consecutive years. It’s nice to see a smaller number. But it’s hardly a sign of fiscal prudence to run a $642 billion deficit, is it?

Why people accept this kind of non-thinking baffles us. But it’s the world we live in. Total US debt is now 70% of GDP. Over the last 40 years, the average debt-to-GDP ratio was 39%. This brings us back to the idea we discussed with you yesterday about the viability of the Nation State versus the multinational corporation.

There is no way out of these debts for most of the industrialised Welfare States. They’ve all adopted policies of higher taxes, more inflation, and financial repression. The blue print for the future is clear, and it is miserable, un-free, and filled with press conferences from politicians.

But at some point, people will begin to doubt whether this the most efficient way to organise society’s resources. Take Google for example. It has all the makings of a multi-national super power. Its share price — nearing $1,000 — is a kind of currency. And when governments need to spy on their people, it’s Google they go to.

And then last night it came to us: Western Australia should secede from the Federation and be its own country. It could under-write this move by hiring a private army, or inviting the Chinese in as guests, or leasing itself to Google for 100 years. It’s the only way the state will avoid becoming Germany to the East Coast’s Greece. We’ll elaborate on this idea tomorrow.

Dan Denning
for Markets and Money

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From the Archives…

The Higher the Market, the Harder the Fall
10-05-13 – Vern Gowdie

India’s Balance of Trade — a World out of Balance
9-05-13 – Greg Canavan

How the Dow is Just Wall Street’s Marketing Tool
8-05-13 ­– Dan Denning

Watch Out For When Australia’s Terms of Trade Goes Back to ‘Normal’
7-05-13 – Greg Canavan

The Greatest Wealth Transfer in History
6-05-13 – Bill Bonner

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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